AGRICULTURAL OUTLOOK                                     August 23, 1999
September 1999, ERS-AO-264              
Approved by the World Agricultural Outlook Board
-------------------------------------------------------------------------
AGRICULTURAL OUTLOOK is published ten times a year by the Economic
Research Service, U.S. Dept. of Agriculture, Washington, DC 20036-5831.
Please note that this release contains only the text of AGRICULTURAL 
OUTLOOK -- tables and graphics are not included. 

Subscriptions to the printed version of this report are available from 
the USDA order desk.  Call toll-free, 1-800-999-6779 and ask for stock 
#SUB-AGO 4001, $65/year.  USDA accepts MasterCard and Visa.
-------------------------------------------------------------------------
CONTENTS

IN THIS ISSUE

IN BRIEF Ag Policy: Potential Impacts of an Agricultural Aid Package
Livestock, Dairy, & Poultry: Hog Prices to Strengthen in 2000 Specialty
Crops: Smaller Apple CropCould Lift Prices in 1999/2000 Field Crops: U.S.
Durum Stocks to Expand Sharply Despite Smaller Crop

COMMODITY SPOTLIGHT Soybean Prices Plummet to Lowest in 27 Years

WORLD AGRICULTURE & TRADE NAFTA: The Record to Date U.S.-Mexico Sweetener
Trade Mired in Dispute

FOOD & MARKETING Cargill's Acquisition of Continental Grain: Anatomy of a
Merger

SPECIAL ARTICLE Mexico's Pork Industry Structure Shifting to Larger
Operations

IN THIS ISSUE

Farm Aid Package Would Offset Low Crop Prices

The $7.4-billion farm aid package passed by the U.S. Senate on August 4,
1999, was a response to this year's low field crop prices.  The House of
Representatives is expected to consider a similar measure after the
August congressional recess, and if the aid is delivered before the
calendar yearend, the legislation would raise 1999 total net farm income
well above last year's level and the average level of the 1990's.  

Drought relief is not part of the current Senate legislation, despite
extremely dry weather affecting parts of the country, particularly the
eastern U.S.  The drought's impact on commodity receipts in 14 affected
states is estimated at $975 million, while the combination of shrinking
receipts and higher expenses (e.g., additional feed purchases) could be
as much as $1.1 billion, according to a preliminary assessment by USDA's
Economic Research Service. Mitchell Morehart (202) 694-5581;
morehart@econ.ag.gov

Soybean Prices Plummet to Lowest in 27 Years

Farm prices for U.S. soybeans are expected to plummet to their lowest
level since the 1972/73 marketing-year average as farmers confront the
third consecutive year of record soybean crops.  As supplies mount,
prices are expected to fall to $4.10-$4.90 per bushel in 1999/2000 from
$5 per bushel last season.  Compounding the impact of a bumper crop is
the uncommon concurrence of weak prices and exports in 1998/99 nearly
doubling U.S. ending stocks from a year earlier.  Until world demand can
work down large global stocks of soybeans and soybean products, U.S.
producers will rely on government marketing assistance loan benefits to
support their incomes.  Mark Ash (202) 694-5289; mash@econ.ag.gov

Anatomy of a Merger: Cargill's Acquisition of Continental Grain

An agreement in October 1998 to combine two of the nation's largest grain
trading businesses appeared to many observers to illustrate a disturbing
trend: increasing concentration in agribusiness leading to fewer
marketing choices and lower prices for farmers. The Department of
Justice, which decided a review of the merger was warranted, concluded
after an investigation that the merger could proceed under certain
conditions.  Cargill and Continental were required to divest themselves
of 10 elevators in 7 states, and the firms agreed to comply over the next
few months.  A review of the economic issues helps explain the outcome of
the case.  James MacDonald (202) 694-5391; macdonald@econ.ag.gov

NAFTA: The Record to Date

The North American Free Trade Agreement (NAFTA) has generally contributed
to the expansion of U.S. agricultural trade with Canada and Mexico. 
Agricultural exports to these two countries have risen from an annual
average of $7.4 billion during 1989-93 to $11.3 billion during 1994-98. 
For several U.S. agricultural exports, NAFTA has had a relatively large
proportional impact, including beef and processed tomatoes destined for
Canada, as well as cattle, dairy products, apples, and pears destined for
Mexico.   Agricultural imports from Canada and Mexico have also
increased--climbing from an average $6.2 billion during 1989-93 to $10.5
billion during 1994-98.  NAFTA has boosted U.S. imports of Canadian beef
and Mexican peanuts more than 15 percent.  More general gains from the
agreement include reorientation of trade in which regional, cross-border
exchanges may replace less economical within-country exchanges.  Steven
Zahniser (202) 694-5230; zahniser@econ.ag.gov

U.S.-Mexico Sweetener Trade Mired in Disputes

The Mexican and U.S. Sugar Industries, and the U.S. high-fructose corn
syrup (HFCS) industry continue to disagree over interpretation of the
North American Free Trade Agreement (NAFTA).  While trade in sweeteners
between Mexico and the U.S. was addressed directly by provisions of
NAFTA, pressure on trade agreements has increased as these industries
have grown, leaving the future of U.S.-Mexico sweetener trade uncertain. 
Stephen Haley (202) 694-5247; shaley@econ.ag.gov

1999 Apple Forecast: Production Dips, Prices to Rise

USDA's August forecast for 1999 U.S. apple production is 10.6 billion
pounds, down 7 percent from 1998 and 3 percent below the 5-year average. 
Reduced production is expected to lift apple prices for the 1999/2000
marketing season, but may also limit exports of fresh-market apples. 
Higher ending stocks of processing apples in 1998/99, and increased 
production in areas where processing apples account for a large share of
output, raise prospects for U.S. apple juice and cider exports in
1999/2000.  Agnes C. Perez (202)694-5255; acperez@econ.ag.gov

The Changing Structure of Mexico's Pork Industry

Rapidly changing swine production technology, intensified disease control
measures, increased foreign trade activity, and economic and policy
shocks over the past quarter of a century have combined to produce marked
change in the Mexican pork industry.  A joint study by USDA's Economic
Research Service and Mexico's agriculture ministry examines developments
in hog farm structure, slaughter infrastructure, vertical integration,
and market efficiency, and their implications for the future of the
industry in Mexico.  Leland Southard (202) 694-5187; southard@econ.ag.gov

BRIEFS

Ag Policy: Potential Impacts of an  Agricultural Aid Package 

The $7.4-billion farm aid package passed by the U.S. Senate on August 4,
1999, was a response to this year's low field crop prices. The House of
Representatives is expected to consider a similar measure after the
August congressional recess. Drought relief is not part of the current
Senate legislation, despite extremely dry weather affecting parts of the
country, particularly the eastern U.S. and Pacific Northwest. Legislation
incorporating disaster and related relief may be forthcoming once the
full impacts are known.

What are the impacts of the $7.4-billion package, if enacted, and how is
the agricultural sector faring during the current market downturn?

Farm income under the aid package would increase by about $6.7 billion
spread over calendar years 1999 and 2000. Not all of the proposed aid is
in the form of direct payments to farmers and landowners. The package
includes other items (e.g., additional crop insurance and cotton
marketing payments) that benefit the farm sector but do not directly
boost income. If the aid is delivered before the calendar yearend, the
legislation would raise 1999 total net farm income well above last year's
level and the average level of the 1990's. However, the effect of aid on
farm income will vary by region and enterprise.

The current USDA forecast for net farm income is $43.8 billion for 1999
(excluding any subsidies from potential 1999 legislation), down just $300
million from 1998 and $1.7 billion below the 1990's average. In addition
to government payments under the 1996 Farm Act, farm income in 1999 is
already bolstered by government support provided under the 1999
Appropriations Act (passed in October 1998). Under existing legislation,
total direct payments are forecast at $16.6 billion for calendar 1999, up
from $12.2 billion in 1998 and second only to the 1987 record of $16.7
billion. More than $6 billion of direct payments in 1999 are forecast to
be loan deficiency payments (LDP's), which are available to producers
when farm prices drop below government loan rates for marketing
assistance loan crops. This is well above 1998, when LDP's amounted to
nearly $2 billion.

Stable production expenses and stronger receipts for some commodities
(notably beef, fruit, and nursery and greenhouse products) have mitigated
the impact of low grain prices on sector-wide farm income in 1999. In
contrast to field crops, livestock receipts are expected to remain the
third highest in the 1990's, although they are forecast to decline
slightly in 1999 from 1998 levels.

Financial problems currently faced by producers are primarily related to
cash-flow. In the 1980's, by comparison, a number of other factors led to
a widespread financial crisis in the agricultural sector including high
interest rates, sharp declines in asset values, and excessive debt,
combined with a weak, inflationary nonfarm economy. Direct payments under
an aid package would ease current cash-flow problems, particularly for
producers of program crops in the Midwest and southern regions of the
U.S. where net income is declining the most, and in the Great Plains
where farm businesses are experiencing persistent debt repayment
problems. 

Aside from farm income and cash-flow impacts, legislation to inject more
money into the agricultural sector has implications for land values and
for Federal budget outlays.

Land markets take into account current and future income from government
payments. The steady stream of farm payments under the 1996 Farm Act, for
example, is "bid into" land prices. This in turn can result in higher
rental rates for farmers who lease land. Any additional payments provided
under "emergency" spending such as the 1999 Senate bill would have a
similar effect on land values if frequent emergency assistance packages
lead to an expectation of government support during market downturns.

Producer planting decisions could be affected if these payments increase
farmer expectations of future emergency spending legislation. In the near
term, plantings could also be influenced by marketing assistance loan
benefits if market prices are below loan rates.

If the Senate version of legislation for supplemental spending is
enacted, total Federal outlays on agricultural programs (net outlays paid
through the Commodity Credit Corporation) could rise above $20 billion in
fiscal 2000 (including direct payments, export programs, and net
commodity purchases). This would be the third-highest Federal
agricultural spending level ever and more than four times this decade's
lowest level.  

Mitchell Morehart (202) 694-5581 morehart@econ.ag.gov

BOX--AG POLICY

Drought Is Reducing Farm Income Prospects in Eastern U.S.

Farm income is expected to be hard hit in some states as drought and
excessive heat hamper agricultural production in the Mid-Atlantic, New
England, and parts of the eastern Corn Belt.  Fourteen states have at
least two counties with extreme rainfall deficits.  The drought combined
with the heat wave has slashed crop yields, reduced livestock
productivity, and raised death rates for some livestock.   

The impact on commodity receipts in the affected states is estimated at
$975 million, according to a preliminary assessment by USDA's Economic
Research Service based on information as of August 16.  The potential
reduction in farm income in drought states could be as much as $1.1
billion, reflecting both shrinking farm receipts and higher expenses for
feed and utilities (e.g., electricity for irrigation).  However,
expectations for higher yields and production for unaffected commodities
may offset the negative impacts of drought on overall financial prospects
in 1999.

The potential reduction in farm income represents a 55-percent decline
from 1998 in Pennsylvania and a 42-percent drop in New York. For the
region, commodity receipts decline 3 percent while the combination of
shrinking receipts and higher expenses is a 19-percent reduction from the
1998 farm income base.  

In addition to the eastern states, the Secretary of Agriculture has
designated parts of several western states (e.g., Arizona, New Mexico,
Nevada, and Montana) as drought disaster areas. Information on impacts
there was unavailable at the time of this analysis.  

Mitchell Morehart (202) 694-5581; morehart@econ.ag.gov

For more information on current farm income forecasts, visit the Farm
Business Economics Briefing Room on the Economic Research Service website
at www.econ.ag.gov

BRIEFS

Livestock, Dairy, & Poultry; Hog Prices to Strengthen in 2000

U.S. pork production is expected to set another record in 1999,
pressuring prices down from the already relatively low 1998 average.
Expectations are based on slaughter in first-half 1999 and on the June 1
market inventory of all hogs and pigs weighing under 180 pounds. While
producers' returns improved dramatically in first-half 1999 over
fourth-quarter 1998, when hog prices were the lowest in half a century,
returns remain generally unfavorable. 

The year-over-year decline in prices will likely encourage producers to
reduce herds in 1999, leading to a modest pork production decline in
2000. With the decline in pork production and tighter competing beef
supplies expected in 2000, hog prices should register a moderate gain. 

USDA's Hogs and Pigs report released in June indicates that producers
continue to reduce herds. However, the reduction is less than previously
expected, as low feed costs have partially mitigated the impact of low
hog prices. While producers reported intentions in March to have 7
percent fewer sows farrow during March-May than a year earlier, actual
farrowings during the period were only 3 percent lower. The June 1
inventory totaled 60.5 million head, 3 percent below a year ago but 1
percent above March 1, 1999. Breeding hog numbers totaled 6.5 million
head, down 6 percent from a year ago but virtually unchanged from March
1. 

The June 1 market hog inventory suggests about a 3-percent decline in
second-half 1999 hog slaughter compared with a year earlier. However,
with expected heavier average dressed weights (based on weights this year
and on trend weights), pork production in second-half 1999 will likely
decline only about 1 percent. As lower farrowing intentions partially
offset a continuing rise in pigs per litter, pork production in
first-half 2000 will decline about 3 percent from a year earlier. Average
dressed weights are expected to be virtually unchanged. Expected low feed
prices and continued expansion of large, lower cost operations will
likely moderate the decline in production as smaller and higher cost
operations exit the industry. 

With hog slaughter quite high in June and July, hog prices dropped from
the high $30's per cwt in May to near $30 in late July. Other factors in
this year's steep price slide include abundant supplies of competing
meats, large cold-storage stocks of pork, and the market's realization
that the hog production cutback was less than indicated in March. Prices
rallied in August, but they are expected to decline in September as
slaughter rates rise seasonally.

In the fourth quarter, prices are expected to slip into the $20's per cwt
at times due to heavy weekly slaughter. Hog prices for this year are
expected to average $30-$32 per cwt, the lowest since 1972 and about $3
below last year's average. However, prices are unlikely to drop to the
extreme low of near $10 per cwt reached late last year.

In 2000, declining per capita pork supplies and less competition from
beef may boost average hog prices into the mid-$30's per cwt. Pork stocks
should decline, and commercial pork exports are expected to be about the
same as this year.

Composite retail pork prices are expected to average 1-2 percent lower
this year than in 1998, due to record supplies of pork and competing
meats. As these supplies moderate, retail pork prices are expected to
return to 1997-98 levels. 

Retail pork prices have remained relatively steady despite the volatility
of  hog prices. Retailers have found that they can move pork off the
shelf without large price discounts. Consumer incomes are strong,
increasing the demand for meat. Over time, pork demand appears to have
increased in response to higher quality, greater consistency, and larger
cut size offered by the industry. Growing pork supplies have not yet
outpaced rising retail demand at current prices.  

Leland Southard (202) 694-5187 southard@econ.ag.gov

BRIEFS

Specialty Crops: Smaller Apple Crop Could Lift Prices   In 1999/2000

USDA's August forecast for 1999 U.S. apple production is 10.6 billion
pounds, down 7 percent from 1998 and 3 percent below the 5-year average.
Lower production expected in much of the Western States region will
likely offset anticipated increases in the Central States and Eastern
States regions. The smaller crop may lift apple prices for the 1999/2000
marketing season from 1998/99 when season-average prices fell 20 percent
to 12.3 cents per pound. Expected reduced production of pears, a
competitor crop, may place additional upward pressure on apple prices
this fall.

Apple production in the Western States region is expected to be 6.3
billion pounds in 1999, down 18 percent from a year ago. Smaller crops
are expected in all states in the region except California.   The
Washington apple crop is forecast at 5.2 billion pounds, down 19 percent
from last year's record, and is expected to mature about 2 weeks late.
Apple orchards in the state bloomed variably, with lighter (sparser)
blooms for Red Delicious and Fuji apples. A relatively cooler spring,
some frost damage, and a likely reduction in crop acreage also reduced
potential crop size. Similar weather conditions prevailed in Oregon,
where the crop is expected to be down 11 percent from a year ago. While
the California crop is also developing behind normal due to relatively
cooler spring temperatures, adequate dormancy and dry weather have
provided conditions for a better crop this year. Production there is
forecast to rise 1 percent to 825 million pounds.

With higher production expected in nearly all the apple producing states
in the Central States region,  the regional forecast is up 12 percent in
1999, to 1.5 billion pounds. Throughout Michigan, which accounts for 71
percent of the Central States' total, orchard blooms were generally good,
and weather, especially during pollination, was mostly favorable.
Although harvest in Michigan is also expected to be delayed, production
is forecast up 8 percent from a year earlier. 

Apple crops in the Eastern States region are also expected to increase by
18 percent overall, to 2.7 billion pounds. For most of the region,
weather conditions have generally been favorable, especially during the
bloom stage, with only minimal frost damage reported. Despite low
moisture conditions, 1999 production is expected to be up 13 percent in
New York and 27 percent in Pennsylvania. Production is also expected to
be up in Virginia, North Carolina, and West Virginia. 

The U.S. Apple Association reports that as of July 1, 1999, U.S. apple
holdings totaled 17.3 million bushels, with fresh- apple holdings
accounting for 13.1 million bushels, up 18 percent from the same time
last year. However, because of the late start of the 1999 fall apple
crop, fresh-apple holdings from the 1998 crop will be drawn down during
an extended marketing period before the new 1999 crop reaches the market.
The expected smaller crop in Washington the largest supplier to the
domestic fresh apple market will likely push fresh-market supplies down
from last year. Reduced supplies, coupled with lower holdings from the
1998 crop because of the extended marketing period, will help boost this
year's grower prices for the new crop of fresh-market apples.

During August 1998-May 1999, U.S. exports of fresh apples increased 24
percent, to 1.3 billion pounds, assisted in part by record-large supplies
of relatively good-quality fruit, particularly from the Pacific
Northwest. Exports averaged 23 percent of U.S. fresh-market production in
1994/95-1998/99. Shipments to key Asian markets have shown marked
improvement, with shipment volumes to Taiwan up 5 percent, to Hong Kong
up 2 percent, to the Philippines up 61 percent, to Malaysia up 21
percent, to Singapore up 83 percent, and to Japan up 189 percent. Exports
to Mexico rose 117 percent, reflecting the reduced harvest there last
year and the March 1998 lifting of the 101-percent antidumping duty
imposed on U.S. Red and Golden Delicious apples by Mexico in September
1997. Meanwhile, exports to Canada fell 6 percent, due in part to
increased production there. Export prospects for the 1999/2000 season may
be limited by reduced production, particularly in Washington where the
crop is heavily oriented toward the fresh market.

U.S. imports of fresh-market apples  totaled 227.6 million pounds from
August 1998 through May 1999, 14 percent lower than the same period a
year earlier. Imports accounted for an average 5 percent of the U.S.
fresh-market supply in 1994/95-1998/99. Apple imports from Canada and New
Zealand each providing about a third of U.S. apple imports were down
sharply, but imports from Chile about a quarter of total apple imports
rose 19 percent following record production there.

U.S. apple juice and cider exports in 1998/99 (August-May) declined 17
percent from the same period in 1997/98, to 281,154 hectoliters. While
exports to Japan rose 30 percent, exports to Canada fell 41 percent.
These two countries account for nearly three-fourths of total U.S. juice
and cider exports. Despite the smaller 1999 crop in Washington, prospects
for U.S. apple-juice and cider exports in 1999/2000 have improved. Ending
stocks of processing apples in 1998/99 are higher compared with the
previous season, and production is up in the central and eastern regions,
where a larger share of output is for the processing sector.  

U.S. imports of apple juice and cider from August 1998 through May 1999
totaled 9.1 million hectoliters, up 28 percent from the same period in
1997/98. While U.S. fresh apple imports are fairly insignificant compared
with total U.S. supplies, apple juice imports provided 50-60 percent of
supplies during the 1990's. Argentina and Germany have been major sources
of apple juice, providing about a third, and about 11-25 percent of U.S.
apple juice imports throughout most of the 1990's. Imports from China
have increased substantially during the same period, rising from 3,504
hectoliters in 1989/90 to 1.3 million in 1997/98. In 1997/98 China
surpassed Germany as the second-largest source of apple juice, supplying
about 13 percent of total U.S. imports.

During the 1999/2000 marketing season, U.S. apple juice imports from
China, mostly in concentrate form, may be limited by possible antidumping
duties. On June 28, the U.S. Department of Commerce began a dumping
investigation of apple-juice-concentrate imports from the People's
Republic of China. The investigation results from allegations that China
is selling this product in the U.S. at unfairly low prices, causing
economic injury to the U.S. domestic industry. On the same day, the U.S.
International Trade Commission (ITC) in Washington D.C. also conducted a
preliminary hearing to gather evidence of economic injury to domestic
concentrate producers. On July 22, the ITC announced its determination
citing reasonable indication that U.S. apple juice producers are
materially injured, or threatened with material injury, by imports of
certain nonfrozen concentrated apple juice from China sold in the U.S.
below cost.

Given the ITC determination, the U.S. Department of Commerce will
continue to pursue the dumping investigation If the Department decides
that the domestic apple industry's complaint is valid, it will impose a
tariff on Chinese concentrate imports as of the day of the decision.
(U.S. apple juice producers are requesting a 91 percent duty on Chinese
concentrate imports.) In addition, if the Department finds that large
amounts of juice concentrate were imported from China during the period
of the investigation, the tariff may be imposed retroactively up to a
maximum of 90 days prior to the decision. The Department is scheduled to
announce its preliminary dumping decision by November 15  

Agnes C. Perez (202) 694-5255 acperez@econ.ag.gov

BRIEFS

Field Crops: U.S. Durum Stocks to Expand Sharply Despite Smaller Crop

U.S. harvested area of durum wheat used mainly for pasta production is
projected at 3.9 million acres in 1999, up 5 percent from 1998 and the
largest acreage since 1982. This increase comes despite lower price
prospects for the 1999/2000 marketing year. Apparently, producers
responded to an attractive federally backed insurance policy (Crop
Revenue Coverage insurance or CRC) rather than to market conditions. 

In North Dakota, acreage intended for harvest is up 350,000 acres, 12
percent above last year. North Dakota will account for 85 percent of U.S.
harvested durum acreage in 1999, 6 percentage points above its 1998
share. In contrast, acreage intended for harvest is down in Arizona and
California, where CRC insurance was offered for the fall/winter planted
crop but was not well publicized. 

USDA's August 1 forecast indicates that farmers will harvest 114 million
bushels in 1999, down 27 million from the large crop of 1998. Lower
forecast yield at 29.2 bushels per harvested acre in 1999, down from 37.8
bushels last year will more than offset the expansion in acreage. 

The Northern Plains region, particularly North Dakota, was plagued by
excessive rainfall during the planting season, delaying planting in many
locations. The late plantings, combined with wet conditions in parts of
North Dakota, have hindered crop progress and lowered yield prospects in
1999. In August, the National Agricultural Statistics Service reduced
North Dakota's planted area and intended area for harvest each by 150,000
acres from the June forecast. The crop's slow progress during the growing
season may limit yield potential and increase the crop's vulnerability to
early frost. 

Although production is projected lower, larger beginning stocks (up 40
percent from the 1998/99 level) will increase total supplies to 204
million bushels in 1999/2000, 4 million above last year. With few
high-value alternative uses for durum, continued large supplies will
reduce the price premium producers have received in recent years for
durum relative to other spring wheat. In 1998/99, the average premium for
durum relative to hard red spring wheat was 35 cents per bushel, compared
with an average 81 cents during the 5 previous marketing years. Durum
prices do not necessarily fluctuate in unison with other classes of
wheat, because there is very little substitution between durum and the
lower protein wheat classes e.g., hard red winter, soft red winter, and
white wheats, which are not well suited for pasta production. 

The large supply and a projected slowdown in use will put downward
pressure on U.S. durum prices throughout the 1999/2000 marketing year.
Domestic use of durum is projected at 87 million bushels in 1999/2000,
just above the 5-year average but 14 million below 

1998/99 level. U.S. exports are projected at 40 million bushels, down 11
percent from last season as exportable supplies remain large in foreign
competitor countries (primarily in the European Union and Canada). U.S.
ending stocks are projected to increase sharply to 77 million bushels, 44
million bushels above the 5-year average.

Export sales of durum in 1999/2000 are moving at the same pace as last
year. As of August 5, accumulated export shipments plus outstanding
export sales for 1999/2000 totaled 13 million bushels. 

U.S. price prospects would be dampened even further in 1999/2000 without
projected smaller crops in the European Union, Morocco, and Turkey.
According to USDA's Foreign Agriculture Circular released in August,
world durum production in selected durum-producing countries is estimated
at 24.6 million metric tons in 1999/2000, down 21 percent from last
year's record level. Despite a lower U.S. export projection for the
marketing year, the U.S. will maintain its status as the world's
second-largest exporter, behind Canada.  

Mack N. Leath (202) 694-5302  mleath@econ.ag.gov

COMMODITY SPOTLIGHT

Soybean Prices Plummet  To Lowest in 27 Years

Farm prices for U.S. soybeans are expected to plummet to their lowest
level since the 1972/73 marketing-year average as farmers confront the
third consecutive year of record soybean crops. As supplies mount, prices
are expected to fall to $4.10-$4.90 per bushel in 1999/2000 from $5 per
bushel last season. 

Compounding the impact of a bumper crop is the uncommon concurrence in
1998/99 of lower export demand and weaker prices. U.S. soybean exports
lagged behind the brisk rate of a year earlier, falling from 870 million
bushels to 790 million in 1998/99. 

With many Asian importers still recovering from serious economic crises,
only western Europe and China advanced soybean imports in 1998/99. In
addition, no U.S. soybeans were shipped in calendar 1998 to Brazil and
Argentina, which collectively imported 48 million bushels in late 1997 to
bridge the gap between tight old-crop supplies and new-crop production.
Russia received more U.S. shipments of soybeans and soybean meal in
1998/99, which were mainly donations under the P.L. 480 program. Exports
of U.S. soybean meal and oil also dropped, creating much narrower crush
margins that curtailed domestic soybean crushing. U.S. ending stocks of
soybeans are forecast to swell to about 385 million bushels in 1998/99,
nearly twice as high as a year earlier.

Slow U.S. sales have stemmed in part from large global carry-in stocks
and record soybean production that increased world supplies in 1998/99
and contributed to a highly competitive world market. Brazil's very large
1999 harvest followed last year's record crop and swelled its soybean
exports to an all-time high. The country's currency devaluation last
January raised internal soybean prices and accelerated marketing and
export of both its 1998 stocks and the new crop harvested in April-May. 

Brazilian soybean meal production and exports cooled considerably after
the devaluation, but Argentine crushers have more than compensated for
the Brazilian slowdown. Although adverse weather prevented Argentine
yields from surpassing the previous season's high, farmers planted record
soybean area for 1999 harvest, and Argentine exports of soybean meal have
been soaring since early this year. India also produced a record soybean
crop and exported its inexpensive meal throughout Asia.

Loan Rates Factor into  1999 Soybean Plantings

U.S. soybean acreage has increased each year since 1992. U.S. farmers
planted 74.1 million acres of soybeans in 1999, up from the last year's
record 72.4 million. Ten of the top 12 soybean producing states (those
with the highest average yields) planted record acreage in 1999,
absorbing acres previously planted to corn and wheat. Only a few southern
states planted fewer soybeans than last year, where farmers shifted more
land into cotton and rice. Favorable weather conditions are leading to
expected bumper yields, pushing the 1999 soybean crop estimate to 2,870
million bushels, 113 million bushels greater than the 1998 record.

While total demand is expected to increase, the forecast increase in 1999
production is larger. However large the 1998/99 carryover inventory may
seem, it could pale in comparison to the prospective record 1999/2000
carryout of 540 million bushels. In combination with large wheat and corn
supplies, such stockpiles of soybeans would seriously strain existing
U.S. storage capacity this fall and would further pressure prices down. 

Under these circumstances, it may seem unusual that U.S. farmers would
have planted so many soybeans in the first place. This can be partially
explained by the increase in cropland available for planting soybeans
last spring when U.S. winter wheat acreage declined 3 million acres from
a year ago.

The other major factor for greater U.S. soybean planting is the marketing
loan program, which supports farm incomes when local prices drop below
local loan rates. Rather than sell program crops at low harvest-time
prices, eligible farmers may use a Commodity Credit Corporation (CCC)
marketing assistance loan to pay production expenses, using their crop as
collateral. When prices rise later, they can repay the loan and sell the
crop. However, if prices do not rise, producers may repay the loan at
less than the announced loan rate plus accrued interest whenever the
posted county price (PCP) is lower than the county loan rate (rather than
simply forfeiting the collateral, which was the only option provided
under legislation prior to the 1990 Farm Act). Alternatively,  farmers
may forego putting their crop under loan by receiving a loan deficiency
payment (LDP) on eligible production, a particularly attractive option if
farm storage is limited. The LDP rate is the amount by which the loan
rate exceeds the PCP on a specific date.

Unlike years prior to the 1990 Farm Act, the loan rate does not prop up
cash prices, which can adversely affect international competitiveness.
The absence of a market price floor also prevents accumulation of costly,
hard-to-dispose-of stocks through forfeiture to the CCC. 

According to the statutory loan formula, national average marketing
assistance loan rates for wheat, corn, and oilseeds are required to be no
less than 85 percent of the simple average of prices received by
producers during the preceding 5 years (excluding the high and low
years), subject to specified maximums and a $4.92-per-bushel minimum for
soybeans. In March, USDA announced that the 1999 national average loan
rates for soybeans, corn, and wheat would be set at $5.26, $1.89, and
$2.58 per bushel, respectively, the same as last year. Under the 1996
farm legislation, these loan rates were the maximum allowed. 

At planting time last spring, soybean cash prices for 1999/2000 were
expected to be well below the loan rate. But given relative production
costs and expected yields, farmers favored soybeans over corn. The ratio
of the soybean marketing loan rate and December corn futures, at 2.7-2.8,
was above breakeven level for most farmers. In addition, risk-averse
farmers can better stretch their operating loans by planting more
soybeans, because the U.S. average variable cost of soybean production is
approximately half the cost of corn production (soybean cost is about $81
per acre or $2 per bushel), and soybean yields tend to suffer less under
the stress of dry weather. So, even with weakening soybean cash prices
last spring, farmers were still assured of a better return by planting
soybeans than planting corn.

What would raise prices?  Based on the loan rate formula, the U.S.
soybean loan rate should decline only slightly in coming years. This
would continue to encourage a high level of soybean planting in the U.S.
next year, despite very low market prices. On the other hand, the low
price environment will likely dampen competitors' acreage and stimulate
world demand. Foreign yields could slip as costs rise for imported inputs
such as fertilizer, chemicals, farm equipment, and improved seeds, while
the returns from investing in those inputs fall. Yields have been
remarkably good for all the major producers in the last few years, but
there is always potential for drought to cause crop failure and shrink
supplies.

Weak Vegetable Oil Sector  Likely To Prolong Low Soybean Prices

World soybean production will edge higher again in 1999/2000, to 157.2
million metric tons. The increase is based almost entirely on greater
U.S. output, which should expand not only the volume but also the world
market share of U.S. exports. When planting begins later this year in
South America, weaker soybean prices relative to corn and wheat will
drive South American producers to reduce soybean area.  

The weakened financial situation of Brazilian farmers, inflated
production costs, and intense U.S. competition will offset the
price-enhancing effects of the January currency devaluation. Brazil's
soybean harvested area is expected to decline 3 percent, causing a modest
drop in production from 31 million metric tons to 30.5 million.
Consequently, Brazil's exports of soybeans and soybean meal would slip
slightly.

Likewise, Argentine farmers are anticipated to shift more area from
soybeans to wheat and corn. Argentine soybean crushing should remain
stable in 1999/2000, allowing a slight increase in soybean meal exports.
However, the reduction in available supplies would cut soybean exports
from 3.3 million tons to 2.2 million. Similarly, Paraguay's 1999/2000
soybean production is projected down to 2.85 million tons from 3.1
million this year, resulting in an equivalent reduction in exports.
Offsetting lower soybean meal exports from Latin America is higher
exports of fish meal another high-protein feed which will continue
recovering from the harmful impact of El Nino on 1998 South American fish
harvests.

Cheaper imported soybean meal is supporting global consumption,
particularly within the European Union (EU), the world's largest import
market. However, high rates of crushing in the major soybean producing
countries and high EU supplies of competing oils will also weaken crush
margins in the EU. Thus, EU nations are importing more soybean meal than
soybeans. In 1999/2000, EU soybean meal imports are projected higher to
20 million tons, compared with 16.8 million in 1997/98.

Next year, the EU will begin its agricultural policy reform, known as
Agenda 2000. The incremental reduction in oilseed subsidies and low world
prices are likely to reduce EU oilseed planting. A proposed EU ban on use
of animal proteins in all livestock feed would also encourage replacement
with oilseed meal. As a consequence, EU imports of oilseed and oilseed
meal should be bolstered. 

Weaker prices have diminished the incentive for soybean sowing in China,
reducing projected 1999 output to 13 million tons from 13.8 million in
1998. Recent policy changes will shift the composition of China's imports
further toward soybeans rather than soybean meal and soybean oil. It is
likely that the prospective decline in domestic supplies would boost
China's 1999/2000 soybean imports to near 4.4 million tons from 3.6
million this season. However, a comparatively modest increase in Chinese
soybean meal consumption will continue to limit soybean meal imports.

Elsewhere in Asia, economic growth appears to be on the upswing again,
and lower food prices will help this recovery. As in 1998/99, foreign
food aid and export credits for soybeans and soybean products will be
used as needed to counter problem areas, such as Russia.

For 1999/2000, U.S. soybean crushing is forecast at a record 1,655
million bushels. While an imminent return to the very profitable crush
margins of 2-3 years ago is not anticipated, lower soybean prices and
firming values for soybean meal as foreign competition lessens should
ease the difficulties faced by domestic processors. Meal prices, likely
stabilizing in 1999/2000 at around $130-$155 per ton, were twice that
level only 3 years ago. Large global meat supplies have sharply cut hog
prices, which will lead to decreased pig production and limit U.S.
soybean meal consumption in 1999/2000. Low prices have already promoted
inclusion of soybean meal in livestock rations at liberal rates, so
domestic disappearance can rise only modestly, due mostly to gains in
poultry consumption.

U.S. export prospects are bright for soybeans and soybean meal. The U.S.
dollar has been relatively strong, but exports could benefit from recent
weakening. U.S. soybean exports are forecast to climb to a near record
915 million bushels, up 16 percent from 1998/99. Foreign soybean meal
consumption is forecast up 2.3 million metric tons in 1999/2000 while
foreign production is projected to increase only 0.7 million. U.S.
soybean meal exports will benefit from this gap, and are projected to
rise from 6.95 million short tons this season to 8 million in 1999/2000.

On the other hand, abundant world vegetable oil supplies and fewer
Chinese imports will make exporting U.S. soybean oil a real challenge. A
worldwide boom in planting competing high-oil oilseeds is projected to
lift 1999 global oilseed production. The world's major rapeseed producing
countries (including the EU, China, Canada, and India) all increased crop
area, and sunflowerseed planting rose in Russia and Eastern Europe.
During the last 2 years, world palm oil output sagged from a severe
drought in Malaysia and Indonesia, which caused an atypical price premium
versus soybean oil. But now, a strong recovery in palm oil production is
developing, which should recapture markets throughout Asia and the Middle
East that were lost to soybean oil. And, based on greater Philippine
output, world coconut oil supplies will rebound above the pre-drought
level.

China has recently emphasized greater domestic production and imports of
high oil-content rapeseed and palm oil imports to satisfy oil needs,
which are in greater deficit than protein meal requirements.
Consequently, China is expected to import only 1.3 million tons of
soybean oil in 1999/2000, down from 1.65 million 2 years earlier.

Shipments to India are expected to account for a large portion of the
gains in world vegetable oil trade. In India, even small price shifts can
cause a substantial change in consumption. Lower world prices and India's
reduction in oil import tariffs last year have favored vegetable oil
consumption. While India's domestic output of soybean oil was robust,
total consumption of all vegetable oils grew faster 28 percent in 1998/99
causing vegetable oil imports to soar. Imports in 1999/2000 should
moderate, with palm oil accounting for a larger share.

Even at bargain prices, U.S. soybean oil exports in 1999/2000 are
forecast to decline to 2 billion pounds from 2.35 billion this year.
Intense international competition is expected to depress the national
average price to 15-18 cents per pound, down from 20 cents in 1998/99 and
the lowest since 1986/87. Despite steady growth in domestic soybean oil
demand, record production is expected to swell ending stocks to an
all-time high of 2,470 million pounds.

Until world demand can work down large global stocks of soybeans and
soybean products, U.S. producers will rely on government loan deficiency
payments and loan benefits to support their incomes. Farmers received
loan deficiency payments on three-fourths of the 1998 soybean harvest,
totaling $875 million. With LDP rates around 75 cents per bushel,
payments could exceed $2 billion on soybeans in 1999/2000. While
1999/2000 soybean farm income will not approach the profitable 1997/98
level, LDP's should allow the majority of producers to more than cover
their variable costs of production.  

Mark Ash (202) 694-5289 mash@econ.ag.gov

BOX--SOYBEANS

Chinese Policy Alters Oilseed & Products Trade 

In China, soybeans, soybean meal, and soybean oil are subject to import
duties set at 3, 5, and 13 percent, respectively. In addition, China
levies a value-added tax (VAT) of 13 percent. In 1995, the Chinese
government relaxed import quotas and waived the VAT on soybean meal as a
means of providing support for the domestic livestock sector. The VAT
exemption for soybean meal succeeded in boosting imported supplies for an
expanding livestock sector, pushing imports from a negligible amount in
1994/95 to 4.2 million metric tons in 1997/98. 

The wave of meal imports undermined domestic prices and left processors
with excessive stocks that they could not sell at a profit. In addition,
chronically large differentials between domestic and foreign vegetable
oil prices enticed refiners to circumvent taxes and quotas on imports of
crude soybean oil by not re-exporting the refined oil as required. Large
supplies of oil and meal suppressed crushing margins and led to a great
deal of idle crushing capacity. Yet, surplus domestic oilseed stocks
increased, as access to supplies was discouraged by restrictions on
interprovincial movement. Oilseed crushing plants (mostly state-owned
enterprises) incurred massive losses.

These events sparked a reform program to make crushing facilities
profitable. In 1998, Chinese authorities were able to strengthen
enforcement of import quotas for vegetable oils. China also recently
redefined the list of VAT-exempt feed products to exclude soybean meal
and other oilseed meals. Reducing tax evasion and ending soybean meal's
VAT-exempt status provided a greater incentive to import oilseeds for
domestic processors to turn into protein meal and vegetable oil. As a
consequence, U.S. exports of soybean meal to China fell about 700,000
metric tons in 1998/99 (more than 80 percent) from the previous year.
Imports of soybean meal from all sources are forecast to stabilize near
1.85 million tons in 1999/2000.

WORLD AGRICULTURE & TRADE

NAFTA: The Record to Date

The North American Free Trade Agreement (NAFTA) has generally contributed
to the expansion of U.S. agricultural trade with Canada and Mexico,
according to a report submitted to the U.S. Congress by the Secretary of
Agriculture in mid-August. Implemented on January 1, 1994, NAFTA is
having a dramatic impact on U.S. trade of some agricultural commodities
boosting exports and/or imports substantially above levels that would
have occurred without the agreement while generating a subtle positive
effect on most of the others.

Under NAFTA, U.S. agricultural trade with Canada and Mexico has grown
substantially.  Agricultural exports to these two countries have risen
from an annual average of $7.4 billion during 1989-93 to an average $11.3
billion during 1994-98. Agricultural imports from Canada and Mexico have
also increased climbing from an average $6.2 billion during 1989-93 to
$10.5 billion during 1994-98.

Preliminary evidence suggests that U.S. agricultural trade with Mexico is
expanding at an increased pace. Agricultural exports to Mexico grew at an
average annual rate of 14.4 percent during NAFTA's first 5 years
(1994-98), compared with 11 percent during 1989-93. Agricultural imports
from Mexico are also growing at a faster rate, gaining an average  12.1
percent during 1994-98 compared with 9 percent during 1989-93.

Available information suggests similar growth in U.S.-Canada trade
following implementation of the U.S.-Canada Free Trade Agreement (CFTA)
on January 1, 1989. NAFTA subsumes CFTA, incorporating its provisions
within the expanded agreement. Although statistics for U.S.-Canada trade
before 1989 are not strictly comparable with subsequent data, growth in
agricultural exports to Canada appears to have jumped from an average
annual 6 percent during 1984-88 to 9.6 percent during 1989-93  under
CFTA. Agricultural imports from Canada also grew by 14.1 percent per
annum during 1989-93, much faster than the 10.4-percent rate during
1984-88. After this early spurt of trade growth from the agreement, trade
has continued to expand under NAFTA but at a slower pace, with
agricultural exports to Canada increasing 5.7 percent on average and
agricultural imports from Canada increasing 11 percent.

Besides facilitating growth between parties to the agreement, NAFTA has
also fostered a reorientation of agricultural trade, resulting in U.S.
exporters and importers devoting greater attention to the North American
market. During 1994-98, Canada and Mexico were the destination for 21
percent of total U.S. agricultural exports compared with 18 percent
during 1989-93, and the origin of about 32 percent of total U.S.
agricultural imports compared with 26 percent during the earlier period.

A sizable portion of North American agricultural trade consists of
intra-industry or "two-way" trade. This is particularly true for Canada
and the U.S. Each counts the other as an important export market for a
wide range of common products including grains and feed, livestock and
animal products, and oilseeds and oilseed products. Given the geographic
size and topography of the three NAFTA members, transportation costs may
make cross-border exchanges between two proximate points less costly than
within-country trades between two distant points. Unfortunately, previous
trade barriers often discouraged such beneficial cross-border exchanges.

NAFTA facilitates exploration of cross-border opportunities, thereby
reducing transportation costs. As a result, existing regional patterns of
trade have intensified, and new patterns have been established. For
instance, pork producers in western Canada tend to export to the U.S.
west coast, while U.S. producers tend to export to eastern Canada.
Similarly, Mexican ranchers, when confronted with drought in 1995,
marketed many of their cattle for slaughter in the U.S.

Obviously, not all changes occurring in U.S.-Canada and U.S.-Mexico
agricultural trade since NAFTA's implementation are attributable to the
agreement. Weather conditions, exchange rate movements, changes in
macroeconomic performance, evolving consumer preferences, population
growth, and technological change are  among the factors that have been
particularly influential.

USDA's Economic Research Service (ERS) estimated trade changes from
NAFTA, isolating the NAFTA impact from other factors. For commodities
that were subject to quotas and other quantitative restrictions before
NAFTA, the volume of trade during 1994-98 was compared with  previously
allowed quantities. This assumes no over-quota trading except where
analysts determined that pre-NAFTA limits were not enforced. For
commodities that were subject to tariffs before NAFTA, an economic model
was used to estimate the impact of tariff changes.

NAFTA Impact Varies By Commodity & Country

For several U.S. agricultural exports, NAFTA has had a relatively large
proportional impact i.e., an estimated increase exceeding 15 percent
relative to trade without the agreement. These exports include beef and
processed tomatoes destined for Canada, as well as cattle, dairy
products, apples, and pears destined for Mexico. The agreement has
spurred growth greater than 15 percent in several U.S. imports as well,
including Canadian beef and Mexican peanuts.  NAFTA is estimated to have
depressed U.S. trade for only one commodity-trade partner combination
U.S. imports of Canadian cattle but these imports still experienced an
overall increase during the first 5 years of the agreement.

Among livestock products, beef and pork commerce has benefited
appreciably from NAFTA. U.S. beef exports to Canada are perhaps twice as
high as they would have been without an agreement. Moreover, NAFTA tariff
changes are estimated to have increased U.S. pork exports to Mexico by
some 5 to 10 percent above the level that would have been expected
otherwise. NAFTA may also have offset some of the decrease in U.S. hog
exports to Mexico during the country's economic crisis in 1995. 

U.S. cattle exports to Mexico are estimated to have grown by some 15 to
25 percent because of NAFTA tariff changes. However, increased cattle
trade with Canada has been influenced more by the exemption of Canadian
beef from the 1979 U.S. Meat Import Law than by NAFTA.

U.S. corn exports to Mexico are somewhat higher due to NAFTA than they
would have been otherwise, but strong growth in corn exports in recent
years is due primarily to other developments within Mexico. These include
not only a series of severe droughts, but also the implementation of
domestic policy reforms for example, the government reduced its very high
price supports for corn to be more in line with U.S. and world prices,
and ended its official prohibition against feeding corn to livestock.

The surge in wheat imports from Canada in 1994 was due primarily to
weather-related events, although some increase is attributable to tariff
reductions that began under CFTA and continued under NAFTA. Disease and
wet weather damaged Canada's wheat crop, resulting in an unusually large
supply of lower grade wheat suitable for feed, while flooding in the
Midwest dramatically reduced the U.S. corn crop. U.S. wheat exports to
Canada have been insignificant despite CFTA/NAFTA tariff reductions. In
1998, the U.S. and Canada negotiated an agreement on wheat trade
regulations that should improve U.S. access to Canadian markets.

NAFTA's impact on U.S.-Canada trade in oilseeds and oilseed products
illustrates the expansion of "two-way" trade opportunities, fostering
additional trade in processed products such as vegetable oil and soybean
meal. In contrast, the change in U.S.-Mexico oilseed trade has been
limited mainly to a rise in U.S. exports of both primary and processed
goods particularly soybeans, and vegetable oil from soybeans and
sunflowers.

NAFTA has significantly influenced U.S. cotton trade. Through reduction
of U.S. and Mexican tariffs and rules of origin that favor textiles and
apparel manufactured by NAFTA members from yarn and fiber produced by
NAFTA members, the agreement has stimulated exports to Canada and Mexico.
These reforms coincided with other developments that diminished the
competitiveness of Asian textile and apparel producers during much of the
1990's including difficulties in the Chinese cotton sector and rising
wages in South Korea (prior to its economic crisis).

The U.S. and Mexico are also moving toward liberalized trade in sugar.
NAFTA specifies a formula, based on the difference between Mexico's
projected production and projected domestic consumption, that gradually
expands the duty-free quota for this trade (see page 17). U.S. imports of
Mexican sugar have jumped from $64,000 in 1993 to $23 million in 1998.
The annual average volume of sugar imports from Mexico during 1994-98 was
328 percent greater than its standard, pre-NAFTA allocation of the U.S.
sugar quota.

U.S. exports of vegetables and fruits and juices to Canada and Mexico
have grown during the NAFTA era, rising from an annual average of $1.9
billion during 1989-93 to $2.7 billion during 1994-98. Imports have also
climbed, from an average $1.6 billion in 1989-93 to $2.7 billion in
1994-98. Although North American trade in fruits and vegetables has
generally flourished since NAFTA, it is primarily because of other
factors, such as changing consumer preferences, strong consumer demand in
the U.S., adverse weather conditions, and peso devaluation and subsequent
recession in Mexico during late 1994 and 1995.

NAFTA was expected to raise U.S. tomato imports from Mexico by about 8 to
15 percent above what would have occurred without the agreement. But the
positive influence of tariff reductions on U.S.-Mexico tomato trade has
been tempered by a price-floor agreement between principal Mexican and
U.S. growers. U.S. potato imports from Canada are estimated to be about 5
to 10 percent larger under CFTA/NAFTA tariff reductions than they would
have been otherwise.

NAFTA has had a positive influence on many aspects of U.S. fruit trade.
For example, grape exports have benefited from the end of Mexican import
licensing, and exports of fresh pears to Mexico have expanded, due in
part to tariff reductions that are proportionately larger in relation to
price than reductions for other fruits such as apples. ERS estimates that
U.S. imports of Mexican cantaloupe are some 17 to 25 percent larger than
they would have been without the tariff cuts of NAFTA and the Uruguay
Round agreement.

Occasionally, NAFTA has worked to offset decreases in trade. NAFTA tariff
reductions, for instance, tempered the decline of U.S. sorghum exports to
Mexico during 1995-97, when many Mexican livestock producers switched
from sorghum to corn feeding of cattle. This dampening effect was
particularly important in 1995, when the Mexican economy experienced
severe recession and U.S. agricultural exports to Mexico dropped more
than $1 billion between 1994 and 1995. Lower trade barriers made U.S. and
Canadian exports more affordable to Mexican consumers, while offering
Mexican producers a greater opportunity to market their output outside
Mexico.

Effects Extend Beyond Trade

NAFTA's influence extends well beyond changes in trade flows. In
conjunction with NAFTA, efforts to resolve conflicts related to sanitary
and phytosanitary (SPS) regulations have been given renewed emphasis
through the trilateral NAFTA Committee on SPS Measures. In addition,
producers in the three NAFTA countries have worked to fine tune quality
standards and to participate actively in the formulation of new standards
and inspection procedures. One major innovation is inspection and
approval of produce at a regional level, or sometimes even at the
individual producer level. For example, the U.S. now permits avocado
imports from approved growers in the Mexican state of Michoacn, and 
recognizes the Mexican state of Sonora as being free of hog cholera,
paving the way for hog imports.

Similarly,  Mexico has lifted its ban on citrus imports from Arizona, as
well as from citrus areas of Texas that are not regulated for fruit fly.
When such initiatives are successful, they open the door to new
international markets. However, when SPS efforts stumble, trade tends to
suffer. This was the case with the inspection process originally
established for U.S. apple exports to Mexico, which was so costly to
shippers that it was substantially revised.

NAFTA has likely had a positive, though small, effect on U.S.
agricultural employment. Employment in crop and livestock production
increased slightly (1.3 percent annually, on average) between 1989-93 and
1994-98. At the same time, however, employment opportunities are
narrowing in some agriculture-related industries, such as textiles and
apparel, in which the U.S. is less competitive. While these structural
changes generally predate NAFTA, the accord appears to have reinforced
long-term trends.

The NAFTA Transitional Adjustment Assistance (NAFTA-TAA) Program was
established to provide job training, career counseling, and financial
allowances to workers who lose jobs or whose hours or wages are reduced
as a result of changing trade with Canada and Mexico. Petitions for
assistance may be filed by labor unions, company officials,
community-based organizations, or groups of three or more workers. Of the
1,794 petitions approved between 1994 and 1998, only 19 were in
agriculture.

Despite concern that capital investment in the U. S. farm sector might
decline once the agreement was adopted,  nominal capital expenditures in
U.S. agriculture grew from $13.9 billion to $16.2 billion between 1993
and 1997. In real terms (constant dollars), capital expenditures
increased in 1996 and 1997, reversing declines in 1994 and 1995.

NAFTA has also facilitated the flow of inter-country investments in North
American agricultural production and food processing industries. U.S.
investment in Mexican agricultural production totaled  $45 million during
1994-97, and U.S. investment in Mexican food processing has grown from
$2.3 billion in 1993 to $5 billion in 1997. Similarly, U.S. investment in
the Canadian food processing industry has more than doubled since 1990.
Preliminary evidence indicates that increased U.S. direct investment in
the Mexican food sector complements agricultural trade.

Integration of the North American market under NAFTA has spurred changes
outside production agriculture. For example, Mexico's food distribution
system is in the midst of a major structural change, with supermarket
chains rapidly gaining market share (AO August 1998). Moreover, as the
distribution systems of North America become more closely integrated,
additional strategic alliances are likely to be formed between retail
food chains in Canada, Mexico, and the U.S., accompanied by harmonization
of standards, contracts, and processes of dispute resolution,  and
facilitating greater complementary trade.

Improvement in infrastructure, another important facilitator of trade, is
an additional outcome of the agreement. The Mexican government appears to
be committed to such improvement, already proceeding with significant
investments in road construction, embarking on the final phase of railway
privatization, and making substantial advances in the privatization of
sea and air transportation. These activities should provide significant
dividends to agricultural trade during the next decade.

Although only one-third of the NAFTA transition period has elapsed, many
of the agreement's provisions are already in place. The changes that have
occurred during the first 5 years of NAFTA offer a hint of the accord's
long-term impact. Gains that are already apparent include expansion of
agricultural trade that better utilizes the relative strengths of the
three NAFTA economies; reorientation of trade in which regional,
cross-border exchanges may replace less economical within-country
exchanges; and continued advances in various institutions that facilitate
trade. 

Through elimination of numerous trade barriers, Canada, Mexico, and the
U.S. are enabling economic agents throughout North America to respond
more efficiently to changing conditions and to benefit more fully from
their relative strengths. Ultimately, these developments should lead to a
more integrated and more prosperous North American economy.  

John Link (202) 694-5228 and Steven Zahniser (202) 694-5230
jlink@econ.ag.gov zahniser@econ.ag.gov

BOX--NAFTA

A forthcoming report by USDA's Economic Research Service contains more
information on the impact of NAFTA. Watch for it on the ERS home page
(www.econ.ag.gov).

WORLD AGRICULTURE & TRADE

U.S.-Mexico Sweetener Trade Mired in Dispute

The sugar industry in Mexico and the U.S. and the high-fructose corn
syrup (HFCS) industry in the U.S. continue to disagree over
interpretation of the North American Free Trade Agreement (NAFTA). Trade
in sweeteners between Mexico and the U.S. is addressed directly by
provisions of NAFTA, as well as other trade agreements, but as these
industries have grown, pressure on trade agreements has increased,
leaving the future of U.S.-Mexico sweetener trade uncertain.

The Changing Mexican Sugar  & U.S. HFCS Industries

Behind the Mexican sugar industry's interest in this dispute is the
remarkable rebound in Mexican sugar production since implementation of
NAFTA. As recently as the November-October Mexican marketing year 1994,
Mexico produced only 3.8 million MTRV (metric tons, raw value) of sugar.
By marketing-year 1998, Mexico produced a record of nearly 5.5 million.
Although USDA forecasts a decrease to 5.04 million for marketing-year
1999, the year's production would still be the second highest on record.
USDA projections for marketing-year 2000 put production at 5.15 million
MTRV. 

A combination of increased sugarcane area harvested and recently
instituted technological and producer incentive measures is behind growth
in Mexican sugar production. Harvested area had reached a low in 1992 of
under 482,000 hectares, about 18 percent lower than 1987. By 1997,
producers increased harvested hectares to the 1987 level, but sugar
production was 22 percent higher than the 1987 level. New technologies
have increased sugar recovery rates the percent of cane recovered as
sugar from 9.08 percent in 1992 to 10.77 percent in 1997, and the
effective milling season expanded from 130 to 175 days. Competition
arising from increased efficiencies in the sector have apparently led to
severe financial problems for some sugar companies, but many have been
able to adapt their production processes to more modern methods.

The Mexican government, by providing several different forms of support,
enables the domestic sugar industry to maintain both high domestic prices
and high production levels. A government-controlled development bank for
the sugar industry, the Financiera Nacional Azucarera SA (FINASA), is
estimated to hold over US$1.3 billion of the Mexican sugar industry's
debt. FINASA has provided extensive restructuring assistance to troubled
sugar companies with high debt loads. 

Since 1997 the government has coordinated the amount of sugar that can be
marketed domestically, which effectively establishes the quantity of
sugar that must be exported or held in stocks. The export total is
divided among sugar companies on a pro rata basis. A penalty system
discourages companies from selling their assigned exports on the domestic
market. In addition, the government has subsidized domestic stockholding,
helping to keep 600,000 MTRV out of the domestic market. 

The government also provides support to the industry by controlling sugar
imports. It currently maintains tariff rates of 39.586 cents per kg, high
enough to prevent imports of world-price sugar that would undercut
domestic prices. Under NAFTA, however, Mexico is required by the sixth
year, 2000, to adapt a tariff-rate quota (TRQ) system with rates applied
to third countries that match the tariff levels maintained by the U.S.

Despite government assistance, Mexican sugar companies face an uncertain
future. In addition to the high debt loads of many companies,
productivity gains have not been shared among all 61 sugar mills, and
marketing expertise is also unevenly distributed. Although domestic sale
prices are high at about 20 cents per pound in June and July, exports are
currently being sold at much lower world prices of 5-7 cents per pound. 

NAFTA has allowed for some duty-free access to higher priced U.S. markets
in recent years. Under NAFTA, Mexico's projected net surplus production
of sugar for fiscal year1997 gave it a duty-free quota of 25,000 MTRV to
be shipped as either raw or refined sugar. Since then, Mexico has
qualified as a net surplus producer in both FY1998 and FY1999 and thus
has qualified each year for NAFTA duty-free exports up to 25,000 MTRV. 

The U.S. HFCS industry's interest in the sweetener dispute stems from
expectations that NAFTA provisions regarding HFCS might provide another
market for U.S.-produced HFCS. The U.S. industry has been plagued with
excess capacity the larger HFCS companies have added significant
production capacity, and several new plants have opened. Some experts
have estimated HFCS annual production capacity may have grown by 3.5
million tons (dry basis) between 1994 and 1997.

Although domestic HFCS sales have increased by more than 13 percent
during this period, the increases have not been sufficient to absorb
increases in capacity. Prices have declined as supply outstrips demand.
The ratio of the HFCS-42 spot price to the beet-sugar wholesale price
began to fall below 0.60 in the fourth quarter of 1995, averaged 0.40 for
both 1997 and 1998, then rose to 0.42 in the first quarter of 1999.
HFCS-42 (42 percent fructose) is used mostly in confections and other
processed foods and in beverages. The Bureau of Labor Statistics producer
price index for the HFCS industry (June 1985=100) fell from 117.6 in the
last 3 months of 1995 to an average of 77.6 in 1998, a 34-percent
reduction. As a result, the sector faced tough adjustments, with some
smaller operations leaving the business and others selling to or
attracting investors from among larger companies.

Increased HFCS-55 exports to Mexico raised expectations during this
period. HFCS-55 (55 percent fructose) is used primarily in soft drinks.
Estimates place sugar use by the Mexican soft drink industry in the
neighborhood of 1.4 million tons in the late 1990's, offering a close
natural outlet for excess U.S. HFCS productive capacity. The U.S. Customs
Service reports that HFCS-55 syrup and solids exports to Mexico rose from
nearly 52,000 metric tons in 1995 to over 179,000 mt in 1997 and over
207,000 metric tons in 1998. The Mexican government reports substantially
higher levels of U.S. exports 338,500 mt for 1997 and 285,500 for 1998.

NAFTA Sugar Provisions  Remain in Dispute . . .

U.S. sugar producers closely monitor the potential impacts of the
sweetener trade disagreements under NAFTA. The original NAFTA document,
in effect since January 1994, contained provisions related to trade in
sugar that were opposed by many U.S. sugar producers. They feared NAFTA
provisions allowing increased HFCS exports to Mexico would lead to the
substitution of HFCS  for sugar in Mexico, which would in turn lead to a
Mexican sugar surplus that could be exported to the U.S. In order to
secure support for NAFTA in Congress, the U.S. and Mexican governments
exchanged side-letters that altered the sugar provisions of the original
NAFTA text. Since implementation of NAFTA, however, there has been a
trade dispute between Mexico and the U.S. centering on interpretation of
the content and validity of the side-letter agreement. 

The original provisions of NAFTA subjected Mexican sugar exports to the
U.S. to several conditions. During the 15-year NAFTA transition period,
Mexican exports were to be limited to no more than Mexico's projected net
production surplus of sugar sugar production less domestic sugar
consumption but at minimum, Mexico was allowed to ship 7,258 metric tons
of raw sugar duty-free. For the first 6 years of NAFTA, duty-free access
was limited to no more than 25,000 MTRV. In year 7, the maximum duty-free
access quantity was to become 150,000 MTRV, and in each subsequent year,
the maximum duty-free quantity was to increase by 10 percent. These
maximums could be exceeded, however, if Mexico had achieved net
production surplus status for 2 consecutive marketing years. 

But the side-letter agreement changed key NAFTA sugar provisions. Under
the side agreement, projected Mexican sugar production will have to
exceed Mexican consumption of both sugar and HFCS for Mexico to be
considered a net surplus producer, making it less likely that Mexican
sugar would qualify for duty-free access. In addition, the side letter
provided for an annual limit on duty-free access of 250,000 metric tons
from 2001 to 2007, eliminating the possibility of unlimited duty-free
access should Mexico become a net surplus producer for 2 consecutive
years.

The Mexican government has disputed the validity of the side letter.
Moreover, Mexico maintains that its version of the side letter does not
count HFCS consumption in the formula that defines net surplus producer
status, nor does it limit exports to 250,000 metric tons per annum during
2001-07. Based on its interpretation of the NAFTA agreement, Mexico is
entitled to export total net surplus production to the U.S. on a
duty-free basis beginning in October 2000.

On March 12, 1998, the Mexican Secretariat of Commerce and Industrial
Development (SECOFI) asked for consultations with the U.S. on the
validity of the disputed side letter under NAFTA. No agreement was
forthcoming, so on November 15, 1998, Mexico formally requested a NAFTA
Commission to resolve the issue, although no Commission meeting has yet
been held, by agreement with Mexico. The Commission has several options
for resolution, none of which are binding unless both parties agree. If
the Commission cannot resolve the dispute within 30 days after it has
convened (or another time period agreed to by both parties), either party
may request an arbitration panel to adjudicate the issue. Some observers
expect a negotiated settlement will be reached, but it is difficult to
project the outcome of the dispute.

. . . And HFCS Provisions Fare No Better

A series of investigations and counter-investigations has also developed
from the surge in Mexican imports of U.S.-produced HFCS. NAFTA provides
for duty reductions on Mexican HFCS imports from the U.S. The base tariff
was 15 percent and is scheduled to reach zero by 2004, with 1.5-percent
yearly reductions over a 10-year adjustment period. In December 1996,
however, the Mexican government announced increases in import duties on
HFCS-42, HFCS-55, and crystalline fructose to 12.5 percent, above the
then-current scheduled rate of 10.5 percent, to compensate for damage to
Mexico when the U.S. raised tariffs on Mexican broomcorn brooms. In
December 1998, the U.S. dropped the tariff increase, and as a result,
Mexico dropped its retaliatory duties on U.S. HFCS imports. The
12.5-percent ad-valorem duty was reduced to the NAFTA-specified rate 6
percent by the end of 1998. 

In January 1997, at about the same time that HFCS import duties were
being increased in the broomcorn broom dispute, Mexico's National Chamber
of Sugar and Alcohol Industries, the association of Mexico's sugar
producers, charged that U.S. corn wet millers were exporting HFCS to
Mexico at less than fair value. Mexico's SECOFI initiated an anti-dumping
investigation in February, then imposed temporary tariffs on two grades
of U.S. HFCS in June. The temporary tariffs applied to shipments from
Cargill Inc., A. E. Staley Manufacturing Co., CPC International Inc., and
Archer Daniels Midland Co. After further investigation, SECOFI made the
duties permanent in January 1998, between $63.75 and $100.60 per ton for
HFCS-42 and between $55.37 and $175.50 per ton for HFCS-55 (AO March
1998).

Also during 1998, SECOFI investigated a charge made by the Mexican sugar
industry that HFCS-90 was being imported in order to avoid the
anti-dumping duties that had been imposed on HFCS-55. After a 7-month
investigation, SECOFI imposed compensatory duties, effective September 8,
1998. Imports from A.E. Staley Manufacturing Co. are charged $90.26 per
metric ton, and imports from Archer Daniels Midland Co. are charged
$55.37 a metric ton. 

In February 1998, the U.S. Corn Refiners' Association (CRA) asked for
review of proceedings of Mexico's anti-dumping actions under Chapter 19
of NAFTA. A panel is being formed. 

Parallel to these actions taken under NAFTA, the U.S. Trade
Representative (USTR) announced its intention on May 8, 1998 to invoke a
World Trade Organization (WTO) dispute proceeding to challenge Mexico's
actions. The USTR made two formal requests for formation of a WTO panel
(the first was blocked by Mexico). A preliminary ruling is expected by
January 2000. 

In May 1998, the USTR also initiated an investigation under section 302
of the U.S. Trade Act of 1974, as amended, in response to a petition by
the CRA alleging that the government of Mexico had denied fair and
equitable market opportunities to U.S. HFCS exporters. The CRA argued
that the Mexican government had encouraged and supported an agreement
between representatives of the Mexican sugar industry and the Mexican
soft drink bottling industry to limit purchases of HFCS by the soft drink
bottling industry to 350,000 tons per year in exchange for a 20-percent
discount on sugar for soft drinks. 

On May 15, 1999, the USTR concluded its formal investigation phase
without determining that the Mexican government's alleged practices were
actionable. However, the USTR noted that its investigation had raised
enough questions about the actions of the Mexican government to warrant
further examination and continued consultation with the government on
issues related to trade in HFCS.

Falling World Sugar Prices May  Increase U.S. High-Tier Imports

While ongoing disputes make liberalized sweetener trade between Mexico
and the U.S. uncertain in the near future, recent effects of the falling
world sugar price on the profitability of exporting Mexican sugar into
the U.S. under high-tier tariffs have the potential to substantially
increase the amount of Mexican sugar entering the U.S. 

NAFTA established a declining tariff schedule for high-tier raw and
refined sugar imported into the U.S. from Mexico. During the NAFTA
adjustment period through 2008, the maximum world price at which it
becomes profitable to ship Mexican sugar into the U.S. market increases
annually. When the declining tariff schedule for raw sugar is compared to
the world price level at which Mexican sugar is competitive with U.S.
sugar (assuming marketing costs of 1.1 cents per pound for bringing
Mexican sugar into the U.S., and a U.S. sugar price of 22 cents per
pound), a world price below 7.3 cents per pound in 1999 would introduce
the probability of high-tier imports from Mexico. 

The world price (No. 14 New York contract) averaged 7.05 cents per pound
in February 1999 and dropped to the 5.5-cents-per-pound range in April
and May. Although U.S. raw sugar prices have been higher than 22 cents
per pound through the first half of the year, they dropped to about 21.50
cents per pound recently.

Through April, USDA had not been forecasting significant high-tier
Mexican sugar imports; only 184 STRV (short tons, raw value) had entered
up to that point in the year. (A short ton, 2,000 pounds, is 0.91 metric
ton.) During the first week of May, however, 15,432 STRV of Mexican
high-tier raw sugar entered the U.S. At that point, the data became
available to USDA indicating additional tonnage was awaiting entry that
would bring the total to 120,000 STRV. USDA's projection from that data
depended on whether the sugar would enter before the end of the fiscal
year or be held in bond until the new calendar year, when the NAFTA
high-tier tariff is scheduled to decrease from 13.6 to 12.09 cents per
pound. The August 1999 projection for high-tier Mexican sugar imports
stands at 70,000 STRV and is projected  at 125,000 STRV for fiscal year
2000.  

Stephen Haley (202) 694-5247 and Nydia Suarez (202) 694-5259
shaley@econ.ag.gov nrsuarez@econ.ag.gov 

FOOD & MARKETING

Cargill's Acquisition of Continental Grain:  Anatomy of a Merger

An agreement in October 1998 to combine two of the nation's largest grain
trading businesses appeared to many observers to illustrate a disturbing
trend: increasing concentration in agribusiness that would lead to fewer
marketing choices and lower prices for farmers. U.S. antitrust laws
prohibit mergers that are likely to substantially lessen competition in
an industry, and in the case of the proposed acquisition of Continental
Grain's grain marketing operations by Cargill, Inc., the Antitrust
Division of the U.S. Department of Justice decided a review was
warranted. Such a review can result in halting or allowing a merger, or
in attaching certain conditions to it before it is allowed. A review of
the economic issues in the case may be helpful in understanding concerns
about the merger and the outcome of the Department's review.

The Grain Marketing Business

Grain traders such as Cargill and Continental operate extensive,
independent grain distribution networks that move grain from farms to
domestic processors and foreign markets. The first stage of the system is
usually a country elevator, which offloads truck deliveries of grain from
farmers, then samples, grades, and stores the grain. Country elevators
may also provide drying and conditioning services and may offer a variety
of transport and payment terms to their suppliers. Cargill operates an
extensive network of country elevators, nearly 140;  Continental owns
only 16.

Country elevators, especially those in wheat regions, increasingly ship
grain directly to ports, often using large shuttle trains. But they also
ship by truck or rail to processors, feedlots, and to larger river and
rail-terminal elevators. 

River elevators usually ship grain by barge to port elevators, although
their grain may also move to processors. Rail-terminal elevators ship to
processors and port elevators in large shipments of 3 to 100 rail cars.
River and rail terminal elevators receive grain both from country
elevators and directly from farmers, and may provide drying and
conditioning services as well as a variety of transport and payment
terms. Both Cargill and Continental operate extensive networks of these
elevators Cargill owns 30 river elevators and 63 rail terminals, while
Continental owns 27 river elevators and 14 rail terminals.

All elevators may ship to domestic buyers typically feedlots or
processors. Grain bound for export usually moves through a network of
port elevators, where it is transferred to ocean-going vessels. Port
elevators sometimes buy directly from local producers, but more often
they purchase grain from river, rail-terminal, and country elevators.
Port elevators usually combine grains of different grades, protein
levels, and other characteristics to meet buyer specifications and they
may also clean, dry, or condition the grain to meet those specifications.
Cargill operates 16 port elevators, while Continental operates 6. 

Cargill is the largest and Continental the third-largest U.S. grain
exporter; together the two account for 40 percent of all U.S. grain
exports. The two firms operate large overseas networks of elevators and
trading offices, through which the companies attempt to arbitrage
differences in grain prices, buying grain at times and locations where
prices are low, and selling at times and locations where prices, net of
transport and storage costs, are high.

Key Considerations  In the Merger Investigation

There are two parties in this merger transaction, and thus two questions:
why would Continental sell and why would Cargill buy? In general,
Continental's grain trading business must look more profitable to
Cargill, if run by Cargill, than to Continental. Continental's expanding
operations in livestock feeding and in financial services were requiring
increasing amounts of managerial attention and investment funds within
Continental, making it more difficult to focus attention effectively on
grain trading.

Cargill, in contrast, hopes to reduce Continental's costs by operating
the combined businesses more efficiently. To reach those efficiencies,
Cargill proposes closing some duplicative facilities and reducing
Continental's headquarters staff. In principle, operating costs could
also be reduced. Some elevators could be closed on a seasonal basis,
allowing open facilities to run closer to full capacity. With multiple
facilities at ports, an exporter could assign different facilities to
specific grain cleaning and loading tasks, thereby perhaps operating more
efficiently. Finally, with larger volumes flowing to ports, the exporter
might be able to realize greater scale economies in transporting grain to
ports.

But another advantage of the merger is at the heart of the antitrust
investigation. Acquisition of Continental grain operations by Cargill has
the potential to make the combined businesses more profitable by removing
a competitor in the grain trade, lowering costs through reduced grain
acquisition prices. If the merger does lead to reduced competition, it
would also make Continental worth more to Cargill than to a buyer for
whom Continental was not a competitor (e.g., in a management buyout or
acquisition by a firm not already in grain trading). 

The government must decide whether the merger is likely to reduce
competition, whether the claimed efficiencies are likely to lead to cost
savings that offset the effects of increased market power, and whether
the efficiencies can be realized only by the merger. Operating cost
efficiencies frequently can be achieved through other contractual means.
For example, if there are scale economies in transportation, a firm could
reach agreements with barge firms and other independent grain traders to
combine port-bound grain movements into shipments large enough to realize
transportation scale economies.

Two agencies, the Federal Trade Commission and the Antitrust Division of
the Department or Justice, share responsibility for antitrust
enforcement. In the Cargill/Continental case, the Antitrust Division took
on the investigation because of its previous experience reviewing mergers
in transportation and distribution industries. 

The Department's investigation focused on three issues. First, would the
merger lead to an increase in grain prices paid by Cargill's buyers, such
as feedlots, food processors, and international clients? Second, would
the merger lead to reduction in grain prices paid to sellers, such as
independent country elevators, and ultimately farmers? Third, because the
merger would lead to a reduction of independently owned elevators on the
Illinois River, which provide authorized delivery capacity for the
settlement of Chicago Board of Trade futures contracts, would the merger
make it more likely that futures market prices could be manipulated by
exporters?

The first issue was disposed of quickly. Because grain is traded in
worldwide markets with many players, it is unlikely that Cargill's
acquisition of Continental would allow it to increase world grain prices.
Should prices be raised by one supplier, the buyers, foreign and
domestic, have many alternative suppliers of grain. Consequently, the
investigation emphasized the latter two issues, the increased
possibilities for futures market manipulation and, most important, the
impact of concentration in the market for purchasing grain from farmers.

Could the Merger Lessen  Competition in Grain Buying?

The merger would noticeably increase concentration in port elevator
facilities for corn and soybean exports. To make this determination, the
Department of Justice relied on USDA export inspections data. Because the
data were not designed for use in the analysis of concentration, they are
not ideal. For example, they may miss some intra-company shipments. They
also may not always capture grain ownership accurately, if an exporter
has a marketing agreement to handle grain on behalf of another exporter.
But while approximate, the data were nevertheless accurate enough to
identify merger-induced changes in the number of major exporters at
particular port regions and to measure the broad magnitude of changes in
concentration.

Concentration in grain exports is already high; in 1998, four firms
accounted for 70 percent of all U.S. corn exports and 62 percent of all
soybean exports. Moreover concentration numbers are substantially higher
in specific port regions the four largest firms handled over 80 percent
of export grain flows at important Texas Gulf and Pacific Northwest
ports. 

USDA inspection statistics also show that Continental and Cargill were
the second- and third-largest exporters of corn, behind Archer Daniels
Midland; with the merger, two firms would account for nearly two- thirds
of all U.S. corn exports, and the concentration level of the top four
would rise to 90 percent. The two firms were also the second- and
fourth-largest soybean exporters, and with the merger, concentration
among the top four firms would rise to almost 80 percent of all U.S.
soybean exports. 

These effects would have been stronger in some locations and markets than
in others. In particular, the merger would reduce the number of major
competing exporters in Pacific Northwest and Texas Gulf ports to two, and
in the small Central California export market to one. The merger's
effects on concentration would be much smaller in export wheat markets,
which have considerably more competing elevator operators than do corn or
soybean markets. The effects would also be smaller for corn and soybean
shipments through Louisiana Gulf locations; while Cargill and Continental
were the second- and third-largest exporters there, four smaller firms
also had a significant presence.

The important question for the Department of Justice on the issue of
concentration was whether increases in port concentration mattered that
is, whether higher concentration would provide grain traders with the
opportunity and the incentive to reduce grain prices paid to country
elevators and ultimately to farmers. In order to decide whether changes
in port concentration would affect prices, the Department would have to
address three related issues.

First, suppose that the combined firm could reduce prices for export
grain. Did producers have viable alternatives? In particular, could
farmers respond to falling export prices by simply redirecting grain to
domestic buyers without affecting domestic prices? 

Second, if the combined firm could reduce prices for export grain, and if
farmers had no viable alternative, then exporters would enjoy higher
profits. But in many markets, higher profits will attract entry by new
competitors, who would force prices back up as they competed to get grain
supplies. In short, for concentrated exporters to be able to maintain
lower prices on grain exports, they need some barriers to the entry of
new export competitors. Did such barriers exist in the grain business?

Finally, suppose there were no possibility of new entry and no viable
alternatives for farmers. Would small changes in the number of
competitors be likely to affect competition and prices where there are
few competitors to start with? In other words, should we expect prices to
fall when the number of buyers falls from four to three? From three to
two? From two to one? 

On the issue of viable alternatives for farmers, there appear at first
glance to be many. Domestic corn and soybean consumption exceeds exports,
so very large volumes already flow to feedlots, commercial feed mills,
processors and the like. But the key question is whether export flows
could be redirected to expanded domestic use without driving grain prices
down. The actual domestic demand and supply relationships are such that
redirection would likely lead to noticeable reductions in domestic grain
prices. Moreover, the major grain traders are also major domestic grain
processors and livestock feeders, who consequently stand to gain from any
domestic price reduction induced by concentration in export markets. 

Other alternatives appear equally unappetizing. In principle, producers
of export-bound grain could, when faced with a price reduction, shift to
other crops. But existing cropping patterns suggest that this is not
really a viable alternative in the face of modest cuts in grain prices.
That is, Nebraska corn producers couldn't simply switch to cotton or
lettuce production in response to small reductions in corn prices climate
and soil conditions would make it unfeasible. Producers could also in
principle reroute export flows through other, less concentrated, ports,
but the additional transport costs incurred in rerouting limit the
effectiveness of that strategy. In short, the Department's analysis
suggests that producers do not have sufficient alternatives to escape the
effects of small cuts in grain prices brought about by increased port
concentration.

Regarding entry barriers, what would prevent new rivals from entering and
competing if traders could substantially increase profits by exploiting
concentration in port facilities? Entry into the operation of country
elevators is easy, and plenty of firms enter and exit that distribution
stage each year. Good sites near rail lines and highways are widely
available, and the facilities are neither expensive nor unusually
difficult to operate. 

But port elevators are a different story. These are very large and
expensive structures. Good sites, at deepwater loading spots without
environmental risks but with room to construct barge and rail unloading
facilities, are limited. Since there are only a few of the very large
structures at any port, entry will itself sharply increase port capacity,
leading to sharp near-term pressure on grain and elevator prices in other
words, entry is risky. In the last two decades, there have been very few
instances of new construction of port elevator facilities, suggesting
that barriers to the entry of port elevators are real.

The third issue to consider is the link between number of competitors and
price. There are really no relevant direct studies of the effects of
changes in the number of grain trading competitors on commodity prices.
Several studies in related food and agricultural sectors, however,
suggest that numbers matter i.e., grain prices will fall if the number of
competing buyers fell from three to two or from two to one. Based on
evidence in those studies, on economic theory, on existing evidence on
price relations in the grain trade, and on the alternatives available to
farmers, Department of Justice investigators decided that prices probably
would fall by small amounts as a result of the merger, in the range of
1-3 percent declines in cash prices received by grain producers. Because
trading margins (differences between buying and selling prices) are
narrow, even these small price changes imply large increases in grain
trading profits. Because producer profit margins are also narrow, small
price reductions would lead to noticeable declines in farmer incomes. 

In sum, the investigation led the Justice Department to conclude that
although the merger was not likely to reduce competition in grain
selling, it would likely reduce competition in grain buying. Moreover, on
the question of whether the merger would raise the likelihood of
manipulation of futures market prices, the Department was concerned that
by concentrating operations along the Illinois River, the merger would
leave about 80 percent of the authorized delivery capacity for Chicago
Board of Trade corn and soybeans futures contracts in the hands of just
two firms. The next decision was what to do about it.

Conditions for Approval  Of the Merger

Current law sets a well defined framework for an investigation. Parties
to a merger must, under certain conditions, notify government antitrust
agencies of the merger. An agency then has a specified amount of time to
decide whether it will investigate the merger. If the agency does decide
to investigate, it is allotted a specified amount of time after it
obtains needed information from the parties to decide whether to file
suit to stop the merger. If a suit goes forward, the agency usually asks
a Federal judge for a temporary restraining order (TRO) against the
merger. 

Filing for a TRO sends a strong message to the firms that the agency is
serious about trying to stop the merger. At this point, merging companies
usually take one of three courses of action: they drop the merger, they
prepare to go to court to fight the lawsuit, or they negotiate with the
agency in an attempt to restructure the merger to alleviate the
government's concerns. Negotiation is often in the interests of all
parties, because going to court is expensive, time-consuming, and risky.
In the Cargill-Continental merger, Cargill and the government opted for
negotiation.

The Department of Justice had specific concerns about the merger's
effects on concentration in export flows of corn and soybeans, and it was
particularly concerned about increases in concentration in the Pacific
Northwest, Central California, and Gulf ports. The anticipated effects
appeared to be larger in Texas Gulf sites than in Louisiana Gulf ports,
so the government was more concerned about Texas ports, as well as more
sure of winning in court over these sites. 

The Department was also concerned about the effects of the merger at
several river ports and at some rail terminals, where competing river or
rail-terminal elevators were some distance away and where price effects
were therefore possible. Those included locations along the Illinois
River from Chicago to Morris, Illinois, along the Mississippi River from
Dubuque, Iowa to New Madrid, Missouri, and around  rail terminals near
Salina, Kansas and Troy, Ohio. The Illinois River points were also
important for futures markets, since the merger would have concentrated
the delivery capacity for Chicago Board of Trade corn and soybean futures
contracts. 

The parties reached an agreement in July 1999. The Department of Justice
announced that Cargill and Continental are required to divest themselves
of 10 elevators in 7 states in order to proceed with the acquisition, and
the firms agreed. Continental agreed to sell its port elevators at
Beaumont, Texas, Stockton, California, and Chicago to independent firms.
Cargill was given the choice of selling its Seattle port elevator or
declining to purchase Continental's Tacoma port elevator. Cargill is
allowed to retain the Continental and Cargill elevators at Louisiana Gulf
sites. 

Continental is also required to sell its river elevators at Lockport,
Illinois and Caruthersville, Missouri, and its rail-terminal elevators at
Troy, Ohio and Salina, Kansas. Cargill is required to sell river
elevators at East Dubuque and Morris, Illinois, and to make one-third of
the daily loading capacity at its Havana, Illinois river elevator
available under contract to an independent grain company. The Illinois
river elevators are all points at which Cargill and Continental elevators
are adjacent to one another. In all instances of divestiture, the
acquirer is subject to approval by the Department of Justice, and the
divestitures are to take place within 5, or in some cases 6 months.

In the end, the merger will allow Cargill to expand its network for grain
origination, particularly in the Plains and along the Mississippi River
system. The divestitures will limit the merger's effects on concentration
at key port and river locations, where it is likely that increased
concentration would lead to small reductions in grain prices received by
farmers. And for observers of the process, the review has served to
illustrate the general principles that guide assessment of the effects of
concentration in a market: the role of viable alternatives, the
importance of entry barriers, and the question of how many competitors
are necessary for competition.  

James MacDonald (202) 694-5391 macdonald@econ.ag.gov

SPECIAL ARTICLE

Mexico's Pork Industry Structure Shifting to  Large Operations in the
1990's 

As part of a technical assistance project for emerging markets, USDA's
Economic Research Service cooperated with Mexico's agriculture ministry,
SAGAR, to develop a background study and outlook report on the Mexican
pork industry. The study describes historical developments in technology
use, farm structure, and slaughter infrastructure, and the outlook report
examines critical factors such as disease control and market efficiency
for the future of the industry in Mexico. Some of the information
contained in the final project report, Situacion Actual y Perspectiva de
la Produccion de Carne de Porcino en Mexico 1990-1998, are presented in
this article.

Rapidly changing swine production technology, intensified disease control
measures, increased foreign trade activity, and economic and policy
shocks over the past quarter of a century have combined to produce marked
change in the Mexican pork industry. As in the U.S. hog industry, swine
production in Mexico began to change dramatically in the 1970's with
development of technologically advanced farms that rapidly increased
productivity. High productivity and growing demand vaulted pork to the
lead in the Mexican meat supply, accounting for nearly half the meat
produced in Mexico in 1983 and 1984.

Rapid growth in the early 1980's had been supported by government
subsidizing of the cost of sorghum for feed use. Withdrawal of this
support in 1984 led to a sharp rise in production costs. Combined with
currency devaluation that contracted consumers' purchasing power, this
led to a dramatic fall in demand for pork, sending the industry into a
depression that lasted until the 1990's. 

During this period, the hog industry underwent a second radical
structural readjustment, which consolidated part of the industry and
increased productivity beyond levels achieved in the early 1980's. Higher
productivity and the capacity to utilize improved infrastructure built up
in the 1980's enabled the industry to resume growth in the 1990's.
Despite substantial progress, however, the industry's efficiency
continues to be hampered by a complicated structure of multiple levels of
marketing intermediaries and related commercial interests.

Mexico's Pork Industry In the 1990's

Despite growth through increased productivity in the 1990's, pork
production now accounts for only about a quarter of Mexico's meat
production. A series of crises in the Mexican economy that led to
currency devaluations during the 1980's and 1990's caused the purchasing
power of Mexican consumers to deteriorate. Pork demand dropped as lower
priced meat and nonmeat products were substituted for fresh pork and for
processed pork in cold cuts and sausages. Substitution of poultry meat in
processed meat products is due not only to price considerations but also
to a growing preference among Mexican consumers for products with lower
fat content. 

Mexico's markets opened to imported hogs, pork products, and poultry
products in the 1990's, increasing competition for domestic pork
producers, but the Mexican pork-packing industry was still able to grow
more than 6 percent per year. When increased production led to extremely
low prices in the U.S. in 1998 and 1999, the liberalized import markets
and increased packing capacity developed earlier in the decade in Mexico
allowed U.S. pork producers to find alternative markets for their
products through increased exports of live hogs and pork products to
Mexico. Currently, Mexico is the largest foreign market for U.S. live
hogs and the second largest for U.S. pork products. 

In response to increased pork imports and weakening demand that have
combined to press the Mexican pork industry, the sector is experiencing
structural change. As of the early 1990's, 99 percent of Mexico's 1.9
million hog farms had fewer than 20 animals. But these small operations
accounted for only 52 percent of the country's swine inventory. Larger
operations, accounting for only 1 percent of hog farms, held the
remaining 48 percent of Mexico's hogs.

Although pork is produced throughout Mexico, five states Jalisco, Sonora,
Chiapas, Veracruz, and Yucatan account for nearly half of Mexico's swine
inventory. Easy access to large domestic and export markets has led to a
concentration of the largest operations in a few states. Six states
Jalisco, Sonora, Guanajuato, Puebla, Yucatan, and Michoacan now account
for nearly 75 percent of domestic pork production. Chiapas and Veracruz,
though among the top states in swine inventory, are not among the top
states in pork production because of the predominance of low-productivity
production systems among their producers.

As has happened in the U.S., swine production is becoming established in
some nontraditional areas. In Mexico, the movement has been to
Tamaulipas, Nuevo Leon, Quintana, and Hidalgo, primarily because disease
control has been improved enough in those areas to allow pork production. 

Because hog production is generally located far from population centers,
about 54 percent of hogs must be shipped across state lines for
slaughter. The biggest markets are municipalities in the Mexico City area
in the state of Mexico 2.3 million head, or 53 percent of the swine
shipped across state lines in 1996, were slaughtered in the Mexico City
area. The largest number of hogs shipped for slaughter, 1.6 million, came
from Jalisco; Sonora, Guanajunta, and Michoacan shipped just under
600,000 head each. Together these four states accounted for 78 percent of
interstate swine movements in 1996.

A Three-Tiered Industry

The Mexican pork industry operates under three basic production systems,
separated by technological advancement and level of vertical integration
and associated with distinct geographic locations. These systems may be
identified as technologically advanced production, small commercial
production, and traditional backyard production. Both technologically
advanced operations and small commercial producers have developed in
well-defined geographic locations, while traditional backyard production
is found throughout the country. 

Technologically advanced production systems are state-of-the-art
operations with a high level of vertical and horizontal coordination,
similar to most advanced hog producing systems in the world today.
Technologically advanced operations now account for about half of
Mexico's pork production. These operations are concentrated in the
Mexican states of Sonora and Sinaloa, but large hog companies have also
acquired or begun operations in areas that have not traditionally
produced swine. Thus, technologically advanced operations can also be
found in the states of Mexico, Nuevo Leon, Queretaro, Puebla, Tamaulipas,
Veracruz, and Yucatan, as well as a few in the Laguna Region in the
states of Durango and Coahuila. 

Coordination of production from breeding through finishing ensures a
standardized quality of animals for slaughter. These operations
manufacture their own feed in order to customize rations for the genetic
characteristics and production stage of the animals. Technologically
advanced production systems also increase productivity through meticulous
sanitation and biosecurity measures to control potentially costly disease
problems by preventing the introduction of disease into production
facilities. The Mexican states that are being declared free of classical
swine fever and other damaging illnesses tend to be the states where
these technologically advanced operations predominate. 

Technologically advanced operations may own their own slaughterhouses, or
may share ownership with an association of similar operations. Vertically
integrated slaughter plants are likely to be Federal Inspection Model
(TIF Tipo Inspection Federal) plants, which are state of the art. TIF
slaughter plants were created in 1947 to allow continued exports to the
U.S. after an outbreak of foot-and-mouth disease in Mexico. Currently,
only pork slaughtered in TIF plants can be exported, and then only after
certification by the importing country. Mexico's 33 TIF plants
slaughtered 3.7 million head in 1997, 31 percent of total hog slaughter
in Mexico. The government has set up temporary assistance programs in the
past to channel resources to producers who have their hogs slaughtered in
TIF plants.

Further vertical integration is targeting cutting rooms and lard
rendering operations, which bring the whole processing operation under
company or association control and thereby capture all of the value-added
profits. Thus technologically advanced producers can provide consistent,
high-quality products demanded by consumers while earning the higher
profits generated by additional processing steps. These operations serve
markets in large urban centers, either through supermarkets or butcher
shops. 

Small commercial production systems produce fewer hogs than
technologically advanced operations, not only because they are smaller
but also because their lower technological level keeps productivity
lower. Operations of this type occur throughout the country but are more
concentrated in central and southern Mexico. Their share of the Mexican
pork industry has been decreasing in favor of the growing number of
technologically advanced farms. 

Although most small commercial operations use breeding stock similar to
that used by technologically advanced producers, their sanitary measures
and marketing and slaughter outlets do not meet the standards of the more
advanced farms. Because of their smaller size, rather than manufacturing
their own feed they use commercial feed, which does not always meet the
nutritional requirements of their hogs through the various production
phases. These mismatches decrease feed efficiency, raising feed costs as
farmers purchase additional quantities to achieve adequate slaughter
weights.

Small commercial operations also cannot guarantee the consistently
high-quality hogs required by the slaughterhouses serving technologically
advanced producers, so they must send their hogs for slaughter to
municipal and/or local private slaughterhouses. Municipal
slaughterhouses, managed by local government authorities, are located
throughout the country, although their exact number and slaughter
capacity is not known. In 1997, the Mexican agriculture ministry, SAGAR,
estimated that these facilities slaughtered 4 million head, about a third
of total slaughter that year. Generally these establishments fall short
of modern standards for equipment and hygiene. As a result, and because
of their smaller size, they sell their product in regional and local
markets and in small urban centers, keeping these small commercial
producers from receiving the higher hog prices available to
technologically advanced producers whose hogs will be slaughtered for
sale in the large urban and export markets. 

Traditional backyard production systems are characterized by breeding
stock of low genetic quality, a prolonged fattening period reflecting
minimally nutritious feed or forage, and virtually nonexistent sanitary
management. Traditional backyard production is practiced throughout rural
Mexico and accounts for about 30 percent of Mexican pork production. Pork
produced under these conditions provides a supply of meat in places where
formal commercial channels cannot operate, but this meat is also
considered a human health risk because pork from foraging pigs can carry
teniasis (tapeworm) eggs. Campaigns are underway to control transmission
of this parasite. 

Traditional backyard producers view pigs as an extra source of income.
The hogs are slaughtered on site or in local abattoirs for home use or
for sale in nearby market centers. Little information is available to
quantify the number of animals slaughtered under these conditions, but
estimates for 1997 placed farm and local abattoir slaughter at 4.3
million head, about 36 percent of all swine slaughtered.

Production Costs  Favor Large Operations

Recent data on Mexican pork production costs and returns (January
1994-January 1998) are available from SAGAR only for the technologically
advanced and small commercial producers. Difficulty in quantifying feed
supply, labor utilization, expenses, and revenue received in informal
commercial channels precludes determining costs and returns for
traditional backyard production systems.

Feed cost is the largest expense for both the technologically advanced
and the small commercial production systems, accounting for approximately
62 percent of costs for technologically advanced operations and 75
percent for small commercial operations. The higher cost for small
commercial producers comes largely from purchasing commercial feed at a
higher unit price than technologically advanced producers who can benefit
from economies of scale in purchasing feed or from vertical integration
of feed production as part of their own operations. Expenses for
veterinary medicine and supplies, the second-highest category of cost,
accounted for nearly the same proportion of total expenses in both
production systems, but technologically advanced producers suffer lower
losses from disease and mortality because of strict sanitary and
biosecurity measures. 

Financial expenses i.e., principal and interest payments on loans are
dramatically different for the technologically advanced and small
commercial production systems. Financial expenses account for about 19
percent of total production costs for technologically advanced producers
compared with only 4 percent for small commercial producers. But this
difference is not necessarily to the advantage of small commercial
producers since it reflects the fact that these producers have little
access to credit and cannot afford to maintain feed stocks that incur
financial costs. 

An analysis of pork production profitability data from the January
1994-January 1998 study period, in fact, indicates the highest net
returns have been earned by technologically advanced producers. These
producers showed negative returns only from April 1995 to July 1996,
while small commercial operations showed losses from October 1994 to
January 1997, beginning 6 months before the technologically advanced
producers and lasting 6 months longer.

The high production costs facing small commercial operations because of
their small scale and low level of technology use, combined with the low
prices they receive in smaller markets, have squeezed the small
commercial producers economically, making them the group most negatively
affected by structural changes. Their share of the Mexican pork market
has fallen to around 20 percent in 1998.

As operations using technologically advanced production systems continue
to gain market share through the use of modern distribution channels and
greater territorial coverage, small commercial production will continue
to decline. The Mexican government has encouraged small producers to
contract with technologically advanced companies or to adopt more
advanced technology and form groups with other small commercial
producers, which might ensure their survival. Such groups could achieve
the economies of scale needed by small producers to lower production
costs and provide access to more profitable markets.  

Leland Southard (202) 694-5187 southard@econ.ag.gov

END_OF_FILE